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Is Active Management a Commodity?
It is our business to try to find what we consider to be superior actively managed funds, managed by skilful investors. We may, for example, find an active manager who has delivered strong long-term results to clients, backed by an exceptional approach, tested over the long term. They would, in all likelihood, rate very well with us. Then, again, we may also evaluate a manager with no obvious active investment skill and whose fund has changed managers a few times over the long run. They could, perhaps, receive a negative rating from us. Yet, quite perplexingly, their fees would almost certainly be the same. What is going on?
There are a few factors, but we suspect there are particularly strong ties to their value proposition. In our experience, many active managers are not being particularly clear on their value proposition (how much excess value they expect to add versus their fee) and this encourages fee standardisation. Paying a higher fee for more added value is not the norm and so it feels quite sadly like good active management is priced more like a commodity than something worth paying up for. This is not a good thing.
Let is provide more context to this. We think, as active managers do, that they are in business because they believe they are above average. Put another way, they can demonstrate they have skill that enables them to charge a higher fee than a passive – skill free – alternative. Some active managers are also more skilful than others. And so because some managers should demand a higher fee for a higher quality offering, we would expect that defining their value add would be core to them. Those who can evidence real skill and therefore value add, should quite rightly demand a fee premium.
So, what does a skilful outcome look like over a long period for an actively managed fund? We ask this question in our fund manager due diligence meetings all the time. Can the active manager define it, even in principle? If so, is the fee they charge commensurate with the potential added value? Can they, perhaps, explain what a zero skill outcome may look like too? These are clearly hard, quite subjective questions. But they surely require an answer if an active fee is being charged and, more importantly, if they believe what they have is genuinely valuable.
What sorts of answers do we get to these questions? To generalise, they are usually quite vague or opaque. In part this is justified because it is very hard to establish what excess returns look like with foresight and they may feel like they are committing to a moving target. But, in our experience, it is also something that is not deeply considered, either. For example, the days of saying a fund objective is “to achieve capital growth” should be numbered. It is vague and undifferentiated and says nothing about their raison d’étre – adding excess risk adjusted returns.
So, we can see how customers may well view (some) active management more as a commodity than it should be. And this is a real shame. As we find more pressure on active management to lower fees, our sense is that it should not be a blanket cut. Some active managers are exceptional and should be able to hold their line on fees. But, others, who have a poorer value proposition or ones with lower excess return expectations, should face fee pressure. It is our hope that the downward fee pressure on active managers is therefore not indiscriminate. But we fear it might be.